Breach notices must be taken seriously because failure to act can put your business at risk.
Formal breach notices are generally issued once a dispute escalates and a conciliatory resolution cannot be achieved. However, this is not always the case because some franchisors may resort to issuing a breach notice straight away.
What is a breach notice?
Under the Franchising Code of Conduct (Code), a franchisor is permitted to terminate a franchise agreement if they provide you a breach notice and you fail to remedy your breach in accordance with the requirements of the notice. It is essentially Step 1 in the termination process and used as a formal warning that your business is non-compliant.
A breach notice must:
- specify the provision of the franchise agreement which has been breached;
- set out what you are required to do to remedy the breach; and
- provide a reasonable time for you to remedy the breach.
If the franchisor wishes to rely on the breach notice to terminate the franchise agreement, the notice must also state that the franchisor proposes to terminate the franchise agreement if the breach is not remedied.
If you fully remedy your breach in accordance with the requirements of the breach notice, then the franchisor cannot rely on that breach to terminate your franchise agreement. Otherwise, if you fail to comply with all conditions of the breach notice, the franchisor is entitled to terminate your franchise agreement.
Remember that there are certain circumstances under the Code which entitle a franchisor to immediately terminate a franchise agreement without following the breach notice process, such as fraudulent behaviour.
What should I do?
Receiving a breach notice can be distressing, but don’t panic.
You should read the breach notice carefully together with your franchise agreement, and diarise the deadline that has been given to remedy the breach.
The breach notice should clearly specify what you have allegedly done wrong and how that constitutes a breach of the franchise agreement. Ensure you fully understand exactly what the franchisor requires you to do – if they require you to do 2 things but you only do 1 of those things within the deadline, that’s still grounds for the franchisor to terminate your franchise agreement because a breach must be remedied in full.
Sometimes remedying a breach is simple – overdue payments can be remedied by paying the arrears, whereas failing to stock approved products can be remedied by stocking those products.
If the breach is an ‘easy fix’ then you should fix it immediately. As the saying goes, pick your battles, because refusing to remedy a breach on principle because you are trying to prove a point will place your business in jeopardy.
Once you remedy the breach then you should provide the franchisor with evidence of your actions.
If you dispute the alleged breach, or don’t believe the action required or the time given to remedy is achievable, then that’s when you should try to negotiate a resolution with your franchisor, and/or seek legal advice.
What is a ‘reasonable’ time to remedy a breach will depend on the circumstances. 7 days may be reasonable to pay an overdue account, but 1 day may be reasonable to clean a dirty store. In any case, the franchisor does not need to give you more than 30 days to remedy a breach (which can be problematic if the breach relates to failure to achieve ongoing KPIs or meet minimum performance criteria).
If you don’t think the franchisor has provided enough information in the breach notice to substantiate their allegations, then you should immediately ask them to provide more information.
If you are unable to resolve the issue with the franchisor, then you are entitled to invoke the dispute resolution procedure under your franchise agreement or under the Code. This procedure means that you and the franchisor must endeavour to resolve the dispute, failing which, either of you can call for a mediation. Be mindful that invoking this procedure does not prevent a franchisor from terminating a franchise agreement in the interim if the breach notice isn’t complied with.
No matter what you decide to do, communicating with the franchisor in a conciliatory manner is key. Sometimes breach notices are the result of simple misunderstandings, but sometimes they can be intended to trigger an aggressive response. Remain reasonable and professional.
Is the franchisor acting in good faith?
The Code requires both franchisors and franchisees to act in good faith towards each other. Importantly, ‘good faith’ does not prevent a party from acting in their legitimate business interests. Just because the franchisor has issued a breach notice does not necessarily mean they are failing to act in good faith.
Remember that when you signed the franchise agreement you agreed to comply with the terms of the agreement and the franchisor’s policies, systems and procedures, and the franchisor is entitled to enforce this.
What are the consequences?
Failing to remedy a breach in accordance with a valid breach notice will entitle the franchisor to terminate your franchise agreement. This will normally mean you lose your right to operate (or sell) the franchised business. The franchisor may have grounds against you for damages. It also puts your personal assets at risk if you’ve provided a personal guarantee to the franchisor.
Be mindful that a breach notice can impair your future ability to renew the franchise agreement. It’s a condition under many franchise agreements that the franchisee ‘substantially complies’ with the franchise agreement to be entitled to renew the agreement. Even if you remedy your breach, the fact that you breached the franchise agreement in the past could entitle the franchisor to refuse to renew it in the future.
Unless you genuinely dispute the validity of the breach notice, maintaining your ongoing working relationship with the franchisor should be prioritised. A breach notice will often be a wakeup call that your business values are not aligned with those of the franchisor.
Showing your franchisor that you are taking the issue seriously and that you are actively taking steps to rectify performance issues will not only assist in salvaging this business relationship, but will also help your position should a dispute arise from the situation.
This is not to say that you should necessarily submit to a franchisor’s demands if you believe they are acting unreasonably, in bad faith or outside the parameters of the franchise agreement. Again, seeking legal advice from a specialist franchise lawyer is key if you don’t believe a breach notice is warranted. Time is of the essence, so don’t wait until the day the deadline under the breach notice expires to obtain professional advice. Act early.
Sometimes the damage to the business relationship may already be done once a breach notice is issued, but often the relationship can be salvaged if you and the franchisor are both genuinely committed to resolving the issue.
By Luke McKavanagh, Rouse Lawyers